1. Learning Objective 16-4 Problem 16-1. Cash conversion cycle Primrose Corp has $15 million of sales, $3 million of inventories, $2 million of receivables, and $3 million of payables. Its cost of goods sold is 80% of sales, and it finances working capital with bank loans at an 8% rate. Assume 365 days in year for your calculations. a. What is Primrose's cash conversion cycle (CCC)? Round your answer to two decimal places. ??? d a y s b. If Primrose could lower its inventories and receivables by 11% each and increase its payables by 11%, all without affecting either sales or cost of goods sold, what would the new CCC be? Round your answer to two decimal places. ??? d a y s c. How much cash would be freed-up? Round your answer to two decimal places. d. By how much would pre-tax profits change? -------------------------------------------------------------------------------- 2. Learning Objective 16-4 Problem 16-2. Receivables investment Lamar Lumber Company has sales of $11 million per year, all on credit terms calling for payment within 30 days, and its accounts receivable are $2.2 million. Assume 365 days in year for your calculations. a. What is Lamar's DSO? Round your answer to two decimal places. ??? d a y s b. What would DSO be if all customers paid on time? Round your answer to two decimal places. ??? d a y s c. How much capital would be released if Lamar could take actions that led to on-time payments? Round your answer to two decimal places. -------------------------------------------------------------------------------- 3. Learning Objective 16-9 Learning Objective 16-10 Problem 16-3. Cost of Trade Credit and Bank Loan Loan Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 40, and it currently pays after 5 days and takes discounts. Lamar plans to expand, and this will require additional financing. If Lamar decides to forego discounts, how much additional credit could it get, and what would the nominal and effective cost of that credit be? Assume 365 days in year for your calculations. Round your answers to two decimal places. a. Additional credit = ? b. Nominal cost of trade credit = ? ?% c. Effective cost of trade credit = ? ?% d. If it could get the funds from a bank at a rate of 11%, interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan? Round your answer to two decimal places. ?% -------------------------------------------------------------------------------- 4. Learning Objective 16-4 Problem 16-4. Cash conversion cycle The Zocco Corporation has an inventory conversion period of 64 days, an average collection period of 41 days, and a payables deferral period of 49 days. a. What is the length of the cash conversion cycle? Round your answer to two decimal places. ??? d a y s b. If Zocco's annual sales are $4,829,400 and all sales are on credit, what is the investment in accounts receivable? Round your answer to two decimal places. c. How many times per year does Zocco turn over its inventory? Round your answer to two decimal places. ? x -------------------------------------------------------------------------------- 5. Learning Objective 16-4 Problem 16-5. Receivables investment McDowell Industries sells on terms of 3/10, net 40. Total sales for the year are $1,461,500. 40% of the customers pay on the 10th day and take discounts; the other 60% pay, on average, 82 days after their purchases. Assume 365 days in year for your calculations. a. What is the days' sales outstanding? Round your answer to two decimal places. ??? d a y s b. What is the average amount of receivables? Round your answer to two decimal places. What is the percentage cost of trade credit to customers who take the discount and to those who do not take it? Round your answers to two decimal places. c. Customers who take discount. ?% d. Customers who do not take the discount and pay on Day 40. Nominal cost. ?% e. Customers who do not take the discount and pay on Day 40. Effective cost. ?% f. Customers who do not take the discount and pay on Day 82. Nominal cost. ?% g. Customers who do not take the discount and pay on Day 82. Effective cost. ?% What would happen to its accounts receivables if McDowell toughened up on its collection policy with the result that all nondiscount customers paid on the 40th day? Round your answers to two decimal places. h. DSO = ? ??? d a y s i. Average receivables = ? -------------------------------------------------------------------------------- 6. Learning Objective 16-4 Learning Objective 16-8 Problem 16-6. Working capital investment The Prestopino Corporation produces motorcycle batteries. Prestopino turns out 1,400 batteries a day at a cost of $4 per battery for materials and labor. It takes the firm 22 days to convert raw materials into a battery. Prestopino allows its customers 40 days in which to pay for the batteries, and the firm generally pays its suppliers in 30 days. Assume 365 days in year for your calculations. a. What is the length of Prestopino's cash conversion cycle? ??? d a y s b. At a steady state in which Prestopino produces 1,400 batteries a day, what amount of working capital must it finance? Round your answer to two decimal places. c. By what amount could Prestopino reduce its working capital financing needs if it was able to stretch its payables deferral period to 48 days? Prestopino's management is trying to analyze the effect of a proposed new production process on the working capital investment. The new production process would allow Prestopino to decrease its inventory conversion period to 17 days and to increase its daily production to 1,900 batteries. However, the new process would cause the cost of materials and labor to increase to $12 Assuming the change does not affect the average collection period (40 days) or the payables deferral period (30 days), what will be the length of the cash conversion cycle and the working capital financing requirement if the new production process is implemented? Round your answers to two decimal places. d. Cash conversion cycle = ? ??? d a y s e. Working capital financing = ? -------------------------------------------------------------------------------- 7. Learning Objective 16-4 Problem 16-7. Working capital cash flow cycle The Christie Corporation is trying to determine the effect of its inventory turnover ratio and days sales outstanding (DSO) on its cash flow cycle. Christie's 2005 sales (all on credit) were $146,000, and it earned a net profit of 5%, or $7,300. It turned over its inventory 5 times during the year, and its DSO was 33 days. The firm had fixed assets totaling $33,000. Christie's payables deferral period is 45 days. Assume 365 days in year for your calculations. a. Calculate Christie's cash conversion cycle. Round your answer to two decimal places. ??? d a y s Assuming Christie holds negligible amounts of cash and marketable securities, calculate its total assets turnover and ROA. Round your answer to two decimal places. b. Total assets = ? c. ROA = ? ?% Suppose Christie's managers believe that the inventory turnover can be raised to 8.6 times. What would Christie's cash conversion cycle, total assets turnover, and ROA have been if the inventory turnover had been 8.6 for 2005? d. Cash conversion cycle = ? ??? d a y s e. Total assets = ? f. ROA = ? ?% -------------------------------------------------------------------------------- 8. Learning Objective 16-2 Problem 16-8. Working capital policy The Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $3 million as a result of an asset expansion presently being undertaken. Fixed assets total $3 million, and the firm plans to maintain a 60% debt ratio. Rentz's interest rate is currently 8% on both short-term and longer-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current asset level are under consideration: (1) a tight policy where current assets would be only 45% of projected sales, (2) a moderate policy where current assets would be 50% of sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings before interest and taxes should be 11% of total sales, and the federal-plus-state tax rate is 40%. What is the expected return on equity under each current asset level? Round your answers to two decimal places. a. Tight. ?% b. Moderate. ?% c. Relaxed. ?% d. In this problem, we assume that expected sales are independent of the current asset policy. Is this a valid assumption? _________________ I. Sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs. II. The current asset policies followed by the firm mainly influence the level of long-term debt used by the firm. III. The current asset policies followed by the firm mainly influence the level of fixed assets. IV. No, this assumption would probably not be valid in a real world situation. A firm's current asset policies may have a significant effect on sales. V. Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales. -------------------------------------------------------------------------------- 9. Learning Objective 16-4 Learning Objective 16-6 Problem 16-9. Lockbox system The Hardin-Gehr Corporation (HGC) began operations 5 years ago as a small firm serving customers in the Detroit area. However, its reputation and market area grew quickly, and today HGC has customers all over the United States. Despite its broad customer base, HGC has maintained its headquarters in Detroit, and it keeps its central billing system there. On average, it takes 6 days from the time customers mail in payments until HGC can receive, process, and deposit them. HGC would like to set up a lockbox collection system, which it estimates would reduce the time lag from customer mailing to deposit by 2 days-bringing it down to 4 days. HGC receives an average of $1,900,000 in payments per day. a. How much free cash would HGC generate if it implemented the lockbox system? Round your answer to two decimal places. _________ b. If HGC has an opportunity cost of 9%, how much is the lockbox system worth on an annual basis? Round your answer to two decimal places. _________ c. What is the maximum monthly charge HGC should pay for the lockbox system? Round your answer to two decimal places. _________